Ireland keeps looking for ways to get banks to use their capital to absorb losses

One of the major problems with the Japanese model for handling a bank solvency led financial crisis and its emphasis on protecting bank book capital levels is that it makes it very difficult to get banks to recognize the losses on their balance sheets.

Ireland has tried a number of approaches including pressure from its central bank.

According to an Independent article, the latest effort involves setting up a trust.  In return for a reduction in the mortgage principal balance, the borrower would give the trust a percentage of the ownership of the property.  When the property is sold, the trust would receive its proportional share of the proceeds in excess of the then outstanding mortgage principal balance.  The beneficiary of the trust would be the banks.

I am not going to say whether this is a good or bad idea, but rather just note that the idea's sponsors are promoting the idea as a way to get the banks to use their book capital to address the losses.

THOUSANDS of homeowners who are in trouble with their mortgages could see their monthly repayments fall by up to a third if innovative proposals from international financial-services group IFG are accepted by the banks and the Financial Regulator. 

Under the proposed debt-for-equity scheme, the amount owed by borrowers to their banks would be reduced in return for the handover of a share of their homes to an independent trust....

Speaking to the Sunday Independent, IFG chairman Frank Ryan said that while his company's debt-for-equity swap plan did not amount to debt forgiveness, it would enable both banks and their borrowers to "get out the other side" without suffering the effects of bad mortgages. 

Citing in its proposal the example of an individual struggling to meet a €1,190 monthly repayment on a €220,000 mortgage, IFG says that a debt-for-equity swap -- in which 35 per cent of the home is given over to a trust -- would see the mortgage drop to €145,000. 

Repayments on this reduced principal would fall by €405 a month to a more manageable €785. 

Outlining the scheme's anticipated benefits for homeowners, IFG -- which counts Aer Lingus chairman Colm Barrington amongst its directors -- says that it will help to remove the fear of repossession, ensure continued tenure in the home and spread the problem of the mortgage over a long period. 

Referring to the scheme's potential impact on the balance sheets of banks, IFG says it would improve the status of a large swathe of loans.... 

Asked to describe the type of mortgage holder that IFG's plan would suit if it was introduced, Mr Ryan said: "It will only suit a segment of the market who have an income. 

"It's not debt forgiveness, but it is completely equitable to the point in time where someone was exposed to the property market, so it helps people in proportion to their level of exposure. 

"If you bought a property at the height of the market, you would get greater help than if you bought two years before or two years after the peak."... 

Under the IFG proposal, borrowers signed up to the scheme would be not allowed to sell their homes for five years. Between years six and 10, the proceeds would be used to pay off the outstanding mortgage, with any remaining proceeds paid to the trust to a maximum of the amount transferred to it at the date of the original debt-for-equity swap. Put simply, the trust would only be repaid its original investment. 

The proceeds of any sale after the first 10 years of the deal would go to pay off the mortgage, with any remaining proceeds divided between the borrower and the trust, based on their share of ownership. 

Asked where the proposed trusts or SPVs (special purpose vehicles) buying up the equity in borrowers' homes would source their funding, Mr Ryan said: "The banks will use their provisions to fund the SPV, and the SPV will act independently of the banks....

"All we're saying is that they should use them. The provisions aren't there to be admired. This is a practical application of them."

IMF screws Ireland and then adopts Swedish model for handling bank solvency led financial crisis

In an Irish Times column, the author discusses how the IMF committed Ireland to the Japanese model for handling a bank solvency led financial crisis and its on-going permanent economic decline and now the IMF endorses the Swedish model and its rapid economic recovery.

“BOLD” HOUSEHOLD debt-restructuring programmes can help prevent recessions becoming deeper and more protracted, according to research by the International Monetary Fund.... 

The study said restructuring household debt “can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. 

Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.”

In short, if you adopt the Japanese model and don't restructure the existing debt to what the borrowers can afford to pay, then the real economy faces a hurdle to growth it cannot overcome.

In a chapter of the World Economic Outlook report entitled “Dealing with household debt”, the IMF economists find that recessions preceded by periods in which households have run up large debts tend to last “at least five years”. 

In the case of Japan, we are talking 2+ decades.

The Irish economy began contracting four years ago....

In the case of Japan, the adoption of the Japanese model and not restructuring the debts has led to 2+ decades of recession (its GNP was actually lower in 2010 than 1995).

A number of the case studies cited in the paper may have relevance for the Irish situation.... 

Case studies that examine what happens when the Swedish model is adopted and debt is restructure based on the borrowers' capacity to pay.

The IMF had a significant input into the design of [the debt restructuring] mechanisms as it was the main source of funding to the north Atlantic state when it was unable to borrow after the collapse of its banking system in 2008. 

Specifically, at the urging of the creditor states in the EU, it pushed for the Japanese model of only recognizing losses to the extent that the banks generate earnings in excess of banker bonuses, dividends and modest book capital increases.

The report notes that the case-by-case approach in Iceland to writing off debts of households which had little or no chance of repaying them proceeded slowly....

The Irish banks are not making much money before loss recognition so they have little ability to absorb losses through their current income stream.

The study concludes that a comprehensive framework and an explicit timeframe are necessary for restructuring programmes to be effective. 

This is how the Swedish model works.  The banks are told to recognize the losses on the portion of the debt that the borrowers cannot afford to pay today.  The banks then subsequently retain future earnings to restore their book capital levels.

Given that the authors’ colleagues are involved in overseeing Ireland’s EU-IMF bailout, the strong endorsement of writing down debts may increase speculation that bigger, Iceland-style restructurings could take place here in the future.

Without these restructurings, Ireland's real economy is condemned to a long term recessionary environment.

Separately, and mirroring the situation in Ireland, the report finds that “strong capital buffers may be insufficient to encourage banks to restructure household debt on a large scale, as is evident in the US today”. 

In fact, under the Japanese model using bank capital to absorb losses is explicitly forbidden.  Losses are only taken as earnings are recognized.

Fundamental to the Japanese model is the idea that depositors equate a healthy bank to a bank with positive  book capital levels.  In reality, government deposit guarantees mean that depositors don't care about a bank's capital level and in most cases do not even know what it is.

Fundamental to the Japanse model is the idea that banks only make loans when they have positive book capital levels.  The US Savings and Loan crisis showed this isn't true as these financial firms knew they had negative book capital levels, they were only positive due to a government sanctioned accounting gimmick, and they continued to make loans.

The report acknowledges that government-supported restructuring schemes do involve one group in society effectively subsidising those who benefit from the scheme, but the case for doing so depends on the net cost/benefit for the economy as a whole.

This is true and is the reason that I proposed that Wall Street rescues Main Street.  It seems perfectly reasonable that that after making money leveraging up Main Street during the years leading up to the financial crisis, that Wall Street should not subsidize Main Street in restructuring the excess debt.

Irish banks tell troubled borrowers to cut health care insurance

The Independent carried an article in which it described how Irish banks are telling troubled borrowers to cut their health care insurance.

The fact that banks which were bailed out by the government feel they have the right to make this request of borrowers demonstrates the banks do not expect any meaningful consequences from their bad behavior.

Your humble blogger refers to the bank behavior as bad because there are very well known rules of thumb for what is the maximum percentage of a family's budget that should go to housing while allowing them to maintain a reasonable standard of living.

In the US, the maximum housing expenditure percentage adopted by the Obama Administration is 31% of gross income before tax.  There is no reason that a similar maximum percentage does not exist in Ireland.

Once everyone knows what the maximum housing percentage is, a level the Irish government should set if it hasn't already, there is no reason to discuss how the borrower spends the rest of their money.

Banks are behaving badly, when they try to get the borrower to cut back on their spending above the maximum percentage and requiring the borrower to hand over this money to the bank.

BANKS are telling thousands of families struggling to restructure mortgages they will have to cut back on health insurance, private education, groceries and Sky Sports before any deal can be done. 

Around 1,300 families a month are now getting their mortgage payments reduced -- with the Government admitting last night that more were likely following yesterday's revelation that one in seven homeloans is in trouble. 

The banks have been accused of putting the boot into homeowners who are unable to meet their existing mortgage repayments. 

An Irish Independent investigation can reveal how banks will only agree to change the existing conditions if homeowners:
- Shop in discount stores like Aldi or Lidl instead of local shops or supermarket chains seen as more expensive.
- Change health insurance provider or drop down to a cheaper plan.
- Cut out extra sports or movie packages from their satellite or cable television services.
- Secure a reduction in other loan repayments before coming to the bank for help.
- Take children out of private, fee-paying schools.... 

Homeowners seeking to modify their mortgage repayments must fill out a 12-page financial statement. 

This lists all household spending and income, providing the bank with bank and credit card statements going back three months, according to financial consultant Michael Dowling, who is a member of the Independent Mortgage Advisers Federation.

The form details spending on everything from phone bills, fuel and groceries, to gym memberships, salons and sports events. 

Mr Dowling, who helps households secure a deal from their banks, said pressure from lenders on homeowners in south Dublin to take children out of private schools was leading to bitter arguments. 

“People get very vocal when they are told to take their children out of a fee-paying school and send them to one that does not charge fees,” he said. Demands from banks that people change health insurer or drop down to a cheaper plan were also leading to huge rows, he said. 

David Hall of New Beginning, a group of lawyers who represent mortgage holders in danger of having their homes repossessed, said lenders were challenging households paying for Sky Sports or UPC movie packages, telling them to change to basic TV packages. “Banks should not be telling people how to live in the absence of long-term solutions for mortgage problems,” he added....

A spokesman for the Irish Banking Federation said banks were trying to be as fair as possible. 

He said that some people were willing to compromise on certain items of expenditure while others were not. 

“Each situation is dealt with on a case-by-case basis. It is about working out what people can afford to pay on their mortgage and what they need to maintain a reasonable standard of living.”

Ireland has done what the IMF wanted, but where is its reward?

A Guardian column looks at the issue of Ireland has done what the IMF wanted, but where is its reward?

I bring this column to readers attention not to debate the merits of Keynesian or Austerity based economic policies, but rather to highlight that there is a choice whether to socialize the losses in the banking system in the first place.

I have spent considerable time on this blog focused on the fact that policymakers have a choice in whether or not to socialize the losses of their banking systems.

This blog has looked at previous financial crises and documented that, when deposits are guaranteed, bailing out banks is not necessary. [think Great Depression and Savings & Loans]

In fact, this blog has been the first to suggest that when deposits are guaranteed by the government banks actually have a safety valve function.

They can act as a circuit breaker between excesses in the financial system and the real economy.  They can do this because they can operate for years with negative book capital.

When they act as a circuit breaker, the result is the banks' future earnings pays for the losses in the financial system.

So the choice facing policymakers today really comes down to make the banks pay or make the nation's real economy and its taxpayers pay.

Returning to the Guardian column, we see a discussion of what happens when policymakers choose to make the nation's real economy and its taxpayers pay.

Austerity policies are now widely regarded as having failed, and this failure is increasingly obvious in the country elected to act as Austerity's Child. The banking collapse, and the legacy bequeathed by the Irish state's extraordinary September 2008 bank guarantee, has seen society in Ireland reshaped as a petri dish for IMF, European commission and ECB experimentation. 

Successive waves of cuts have been stipulated bythe Troika in return for its loans, but implemented without resistance, and arguably, a degree of enthusiasm, by the two governments of the "post-sovereign" era. 

The fiscal adjustment, according to economist Karl Whelan, is the equivalent of "€4,600 per person… the largest budgetary adjustments seen in the advanced economic world in recent times". With annual "adjustments" of €3-4bn flagged until 2015, the euphemism of "purposeful austerity" cannot long camouflage the concerted assault on the – already minimalist – social contract. 

With this havoc in its fourth year, it is difficult to recall that 2008 promised what David Graeber describes as "an actual public conversation about… the financial institutions that have come to hold the fate of nations in their grip". As David McNally documents, this promise was merely a preface to the "neoliberal mutation" that insists on states slashing spending to "ensure that working-class people and the poor will pay the cost of the global bank bailout". 

In Ireland, this fleeting public conversation never materialised. Accelerating fiscal deterioration overlapped with the political unravelling of the historically dominant Fianna Fáil party, and the destructive intimacy of bankers, developers and ruling politicians became the prime focus of public anger. As Illan Rua Wall argues, the cathartic defeat of Fianna Fáil in February's election ensured that "indignation burnt itself out at the ballot box", with little public reflection, let alone mobilisation, on the possibility of confronting the new government's effortless adoption of austerity. 

This relative lack of popular opposition is difficult to explain. Official narratives – both domestic and EU – have praised the "maturity" of the electorate; pitted public and private sectors against each other in a "race to the bottom"; and insisted that "we all partied", a moralising patriotism deployed to draw the politics from the socialisation of bank debt, and from serious consideration of alternative approaches. The current Fine Gael/Labour coalition has invested heavily in being "not Greece"; by showcasing further and faster deficit-reduction, Ireland would be rewarded with interest rate cuts, an earlier than predicted return to the bond markets, and thus regain "sovereignty". 

Costas Douzinas recently documented how the IMF blames the failure of its growth predictions, and austerity measures, on the impact of Greek public resistance. Yet in well-behaved not-Greece, the same bad medicine has resulted in a rising deficit, stagnant growth, sustained emigration, and unemployment at about 15%. In its latest quarterly report, the IMF praised Ireland's "exceptional" efforts to meet its targets, but this praise comes at a time when the fiction of a reward for good behaviour is falling apart....

It is clear that "austerity" primarily involves rapidly socialising as much bondholder debt as possible, in advance of a possible default. The recent European council summit meeting may result in making permanent much of the current framework of external oversight of the Irish public finances. The fiscal compact, if passed into law, would constitute the most revolutionary development in the Irish economic landscape in the history of the state. The strengthening of budgetary surveillance by the European authorities, the balanced budget amendment, and the inclusion of automatic, treaty-prescribed sanctions for transgression, could condemn Ireland and other eurozone countriesto lengthy periods of economic stagnation.

Looting of the Irish expands to looting of the Eurozone

This blog has frequently looked at the issue of regulators requiring insolvent financial institutions to increase their book capital ratios.  A subset of this policy is the requirement that insolvent financial institutions shrink their balance sheets at the same time as these institutions are required to maintain high capital ratios.

One hundred percent of the time this capital ratio policy results in the financial institution selling its bests assets at a discount.  It also does absolutely nothing to address the bad debt that is on the financial institution's balance sheet and that is causing them to be insolvent in the first place.

Why does this regulatory capital ratio policy always end up with the best assets being sold at a discount?

The buyers know several facts that reduce the selling bank's leverage in the negotiation.

• The selling financial institutions cannot raise capital from the equity markets because no one can assess their risk or solvency;
• The selling financial institutions have a limited time in which to achieve the target capital ratio -- frequently, the regulators publish a deadline; 
• The amount of assets that the financial institutions must sell is large relative to the capacity of the buyers to acquire - in Europe, banks are trying to shed 3 trillion euros of assets; and
• The selling financial institutions must sell their best assets because recognizing the losses on their bad assets would decrease their book capital levels and move them away from the regulators' targeted capital ratios.

The end result is that the regulators effectively required their banks to sell their best assets at a discount.

I call this "looting" because the taxpayer has been called on to bailout these financial institutions in the past and, unless ultra transparency is adopted, be required to bailout these financial institutions in the future.  When the taxpayer needs to step up for the future bailout, the size of this bailout is increased by the discount the banks realized when selling their best assets.

The NY Times ran an article that gives some idea of how attractive looting the Eurozone financial system is.

As Europe struggles with its debt crisis, American businesses and financial firms are swooping in amid the distress, making loans and snapping up assets owned by banks there — from the mortgage on a luxury hotel in Miami Beach to the tallest office building in Dublin.

The sales are being spurred on because European banks are scrambling to raise capital and shrink their balance sheets, often under orders from regulators. European financial institutions will unload up to $3 trillion in assets over the next 18 months, according to an estimate from Huw van Steenis, an analyst with Morgan Stanley....

At Kohlberg Kravis, Nathaniel M. Zilkha, co-head of the special situations group, is expanding his London team to eight, from two, and hoping to take advantage of opportunities in Europe. The firm is even considering potential investments in the country where the crisis began, Greece, despite headlines warning of a default by Athens or the possibility that Greece may withdraw from the euro zone. 

“If no one is willing to turn over the rocks, that’s when you can make extraordinary investments,” Mr. Zilkha said. “The market dislocation in Greece is creating significant opportunities that wouldn’t be otherwise available.” 

Besides Greece, Kohlberg Kravis bankers have also been looking for deals in Spain and Portugal, where private companies are having a similarly hard time winning new credit or extending existing loans.... 

Experts expect these kinds of sales to jump as European banks race to meet the June deadline imposed by the European Banking Authority to raise more than 114 billion euros in fresh capital. Financial institutions also have to increase their Tier 1 capital ratio — the strictest yardstick of a bank’s ability to absorb financial blows — to 9 percent of assets. 

Banks get a twofold benefit from unloading assets like real estate loans and other holdings; not only do they have more cash, but there are fewer assets they must hold capital against in case of losses, thereby quickly bolstering Tier 1 levels...

Inside his firm, Stephen A. Schwarzman, the chief executive of the Blackstone Group, recently cited the $3 trillion estimate of how much European banks will have to unload, and this summer he told investors that Europe was back on Blackstone’s radar after being absent for several years. 

“As people become increasingly negative on the environment there, we think we are buying good companies at very good values,” he said.

Looting of the Irish: Irish 'bad bank' NAMA should be sold in one go [update]

The Telegraph reports

Ireland should sell the National Asset Management Agency (NAMA) in its entirety once the body has made significant progress in disposing of the toxic property loans it took on from the country’s banks.

More specifically,

A secret report prepared for NAMA, which holds about €75bn (£64bn) of bad debt, said the organisation could be sold as a single entity and also recommended it take direct control of loans currently managed by Irish banks. 

NAMA was set up as a “bad bank” in the midst of Ireland’s banking crisis to enable the country to create new banks unencumbered with toxic loans. 

The emergence of the NAMA report comes as European banks face the need to dispose of a pool of toxic assets larger than the entire British economy if they are to return to profitability and meet new capital rules. 

Estimates from accountants Deloitte found that European banks hold more than £1.5 trillion of non-core and non-performing assets on their balance sheets.

So is the advice in the report to sell as quickly as possible to get out in front of the wave of bad assets that the European banking system is trying to sell off?

Is this advice likely to produce a high or low price for the NAMA assets?

Update
The Telegraph ran an article on the head of NAMA.   The article observed that the goal is not to sell NAMA now but to manage the assets to try to maximize their value.

Irish banks face mortgage strikes

The Guardian carried an interesting article on how distressed Irish borrowers are organizing to demand that banks modify their mortgages to levels that reflect their capacity to pay.

The final straw for the borrowers was the failure of the banks to pass on the ECB's recent adoption of lower interest rates.  The banks have resisted passing it on so as to increase their profit margins - this was not surprising given the Wilbur Ross is now a large investor in one of the two remaining banks.

Should this idea of a mortgage strike spread to say the US ...

It's been a tough time to be Irish. The boom years are a distant memory and now there's just austerity and a long haul back to recovery for a nation crippled by the reckless lending of its banks. 

But, a year after the country was forced to call in the International Monetary Fund(IMF), there is a sign that the people are fighting back and targeting the hated lenders with the "nuclear option" of a mortgage strike. 

Ross Maguire is the co-founder of New Beginning, a new de-facto trade union for Irish mortgage holders and those in debt distress with banks, which aims to recruit 10,000 members in a movement that has strong parallels with the Occupy protests that have swept through scores of countries. 

"The nuclear weapon is for borrowers acting in concert and to say that unless proper and sustainable solutions are put in place which are fair and reasonable, then we should not continue to pay under these current conditions," he says. So does this mean a "mortgage strike" ....

"It is radical but it is where we are going if things don't change. It's the last option but it is better that people like us have control over it because the danger is that if that kind of people power was misdirected it could wreck the financial system. New Beginning doesn't want to smash the financial system; we merely want to reform it and re-balance power between banks and borrowers." 

With more than €70bn (£60bn) of taxpayers' money already transferred into the banks to save them from collapse and public fury intensifying after the banks refused to pass on a cut in interest rates by the European Central Bank two weeks ago, Irish people are bracing to pay a further price for the bailout....

Many blame the fiscal crisis on the banks' reckless lending to property developers – the same banks that are refusing to cut interest rates and threatening to repossess thousands of people's homes. ... 

The quiet 42-year-old who launched this crusade against the banks from his office in a trendy building near Dublin's Smithfield Market area is a barrister. But Maguire is the antithesis of the public perception of well-heeled "silks" in wigs and gowns: he doesn't charge fees for families with distressed mortgages who are fighting to keep their homes. 

After working at the Dublin bar since returning from a successful legal practice in the City of London in the 1990s, Maguire noticed how skewed Irish law is towards banks as opposed to their borrowers. A person declaring bankruptcy in Ireland will be in financial and credit purdah for 12 years, Unlike Britain's 12 months. 

Now he and New Beginning are emerging as lightning rods for the anger of an entire nation towards the banks that they believe helped bust Ireland. ... Maguire and his group, however, offer a legal, non-violent but direct action alternative to challenge bankers' power. 

His own epiphany came last year when he and two colleagues heard of a client who had fallen foul of the banks. "A man came to us who had a loan with the Irish Nationwide building society, which subsequently was forced to merge with the Anglo Irish Bank. He got his file under the Data Protection Act and discovered that the Irish Nationwide had created a completely new version of him for their credit committee! 

"They had changed his occupation. They had given him a salary far higher than his actual one of €30,000 – in fact, they said he was now earning €60,000. They had changed the grade he worked at in his job to a higher one. They had even forged not only his signature but also his employer's. It was incredible in terms of sharp practice. This was all so they could lend him more and more money during the boom. 

"We thought to ourselves that if this happened once across the state it was happening all over.

In the US for example?

It was then that we realised something needed to be done to check the power of the banks and that it had to be done collectively." 

Before they opt for the "nuclear option", Maguire stresses that New Beginning has devised a practical plan to reform the mortgage payment system that will, he claims, help the banks as much as the people. They have proposed to the government an "income annuity mortgage". It would mean a homeowner in difficulty paying a €1,000 a month mortgage could cut that to €700. If things improved, the payments could be raised to, say, €1,500. 

But would the banks accept such a system, which would entail stretching out mortgage payments for longer? 

"The Irish banks don't think we are serious," Maguire says, "but just wait." 

New Beginning are about to go on a nationwide recruitment tour ....

"When we get over 10,000 members, each paying a levy of just €15, we will see who is serious. We are offering a fair solution for all concerned, including the banks, but if ultimately they reject it there is the nuclear option of a payment strike. Individually, people go in mortal terror to meet their banks but together in a national movement they won't be in such a weak position." 

Maguire says they are not firebrand radicals hellbent on destroying the system. "Why throw a brick through a bank window? They will just replace the glass the next day," he points out. 

However, the barrister says they could link up with others in Northern Ireland and Britain, such as the Occupy movement and UK Uncut, who are equally disgusted at the banks' behaviour during this long recession. 

"Two of the taxpayer-rescued banks in Ireland – the Bank of Ireland and First Trust [Allied Irish Banks' UK operation] – have a big presence in Northern Ireland. We would like to help out borrowers who are under pressure from these banks up there too. 

"And I don't see why we couldn't see the establishment of a New Beginning force on the other side of the Irish Sea. We would like to speak to groups like UK Uncut and Occupy over there to help each other and explain some of our ideas for re-balancing the power between bankers and borrowers." 

He suggests his organisation could provide a model on how to reform banks and reduce their power to threaten customers further across the globe. 

"There is widespread discontent across the 'Anglosphere' and elsewhere regarding the banks. We are offering practical solutions on the one hand and the right of borrowers to organise and deploy the ultimate, last weapon of resort on the other."...

"This is a 21st-century struggle to re-balance power in favour of people. Whether in Britain or Ireland, we can find the power to turn off the banks' oxygen if they won't change their ways."

Why don't banks pass on the benefits intended by monetary and fiscal policies? The Irish Experience

In his column in the Independent, Shane Ross looks at what is happening in the Eurozone and concludes that Ireland was played for the fool when dealing with its banking crisis.

Specifically, he looks at Ireland's willingness to defer to the bankers and what Ireland did not receive in return.

I knew that our world was going to end last week ... 

We share similar views about the banks, the euro and we condemn the identical, but failed, policies being pursued by the last government and the current coalition. 

Above all, free marketeers and socialists unite in the belief that the Irish government has put the interests of Eurocrats and bankers above those of Irish taxpayers (free market speak) and workers (Joe Higgins speak) . 

Happily the conflicting ideologies want to put Ireland first, insisting that both governments have surrendered the nation's independence to the threats from outsiders. Both regimes relentlessly practised the doctrine of deference. 

Events last week confirmed our worst fears. Too late. The chickens have come home to roost. 

The doctrine of deference has delivered all right, but to our detriment. This weekend, the devil is at the door. 

The devil struck with venom on Thursday when RTE's news led with the story that Germany and France were in intense talks about the possibility of an exclusive, but strong, eurozone. No doubt they will include Holland, Finland, Belgium and Austria in the new club. They are seriously pondering a relaunch, a strong currency. 

Ouch. Where would that leave Ireland? 

Well first of all Sarkozy and Merkel do not care a hoot. We will be dumped. In Angela's and Nicolas's 'Plan B' Ireland can go jump in a lake. Ireland can join other basket cases like Italy, Greece, Portugal, Spain and maybe Cyprus in a second, ultra-soft eurozone. We will bring our troubles and our debts to the party hosted by the successors of Berlusconi and Papandreou. 

We will be thrown to the European rubbish heap, facing a crisis a week with the other club-med cowboys. A nightmare beckons.... 

It could all have been so different. Imagine if we had burned the bondholders back in 2008, 2009, 2010, or even under Enda's government in 2011, the crisis would have been over by now. We would be in the recovery room. 

On the downside, we would have been in the European doghouse, ticked off by Nicolas and Angela and deeply unpopular with European banks. Not a bad place to be. 

The European banks are now smirking at our doctrine of deference to them. Ditto Angela and Nicolas as they chart their betrayal. 

Even at home the major banks, true to form, eyeballed our most powerful ministers at last week's meeting over interest rates. They told Ireland's sovereign government to jump in a lake. 

They too were ingrained with the doctrine of deference. 

Apparently the Irish banking system needs more capital

Despite multiple rounds of bank recapitalizations, apparently the Irish banking system needs more capital.

According to an article in the Independent,

FINANCE Minister Michael Noonan yesterday admitted that Ireland's banks might need to raise more capital to pass a new round of European stress tests, but said they "should" have enough "headroom" to cope with new targets.

This is not exactly a ringing endorsement of the solvency of the Irish banks given that banks have passed the previous two rounds of stress tests that needed to be nationalized shortly thereafter.

What makes the next round of recapitalization particularly distasteful, is that the banks are not using the capital put in previously to broadly address the problem of over-indebted homeowners and the drag they represent on the economy.

According to an Irish Times editorial,

Extra capital [based on the last round of stress tests] was then provided – mostly by the taxpayer – to allow [the banks to] meet the losses and thus reassure prospective investors and lenders. 

The objective may have been to reassure the markets, but the Government has created an expectation that there would be mortgage debt forgiveness or at least a formal structure put in place to carry out some sort of triage on over-indebted mortgage holders, allowing them to resolve their situations and move on with their lives. 

Instead the Government has put in place a safety net for those who are going to lose their homes and left it up to the banks to resolve the wider issue. It has suggested a few mechanisms such as split mortgages, but there is no compulsion on the banks to offer these alternatives or even exhaust them before moving to enforce their security. 

The Financial Regulator gave a strong speech last Friday promising to make the banks do what is expected of them, but in truth the Government’s main contribution will be an improved insolvency process to allow you tie up the loose ends once the bank is finished with you. 

As a result of all this, the over-borrowed remain at the mercy of the banks they have helped saved. Anyone seeking to resolve their situation has no certainty as to the outcome of the process once they walk into the bank and put their hands up. 

It is likely then that the current situation will pertain where most people struggle on trying to service unsustainable mortgage debt rather than moving to put their financial affairs in order. Situations that could arguably have been resolved in six months will now play out over many years. 

The short-term winners are the banks, as they can now husband the capital injected into them by the taxpayer to deal with these losses and drip-feed it out over the next five to 10 years. 

The long-term losers are pretty much everybody, including the banks, as a very large cohort of people – the over-indebted – will continue not spending, adding to economic stagnation. 

To understand why the Government went down this road you have to assume their mind is focused on the wider economic picture. Or that they have had their mind focused on it for them by the EU and IMF. 

In very simple terms it’s more important for the Government to have strong banks right now than try to lever economic growth through some sort of resolution of the mortgage debt issue. 

If and when Greece defaults the shockwave will run through the European banking system. A repeat of the credit crunch that followed the collapse of Lehman’s is not inconceivable. 

Many countries may be forced to step in and rescue banks, with consequences for their own fiscal positions and credit ratings. 

Ireland to a certain extent is ahead of the curve, having comprehensively recapitalised its banking system. This, plus the banks’ low direct exposure to Greece, should insulate Ireland from this aspect of the catastrophe should it happen.

Except of course that the additional capital was not enough...

Irish lending expertise in looting taxpayers to Greece

According to an article in the Irish Times, the staff of the Irish central bank are advising their counter-parts at the Greek central bank on how to plot a resolution of the Greek banks and restore confidence in the Greek banking system.

At first blush, this seems reasonable.  After all, the Irish banking system has experienced a similar run on its banks as the Greek banking system.

So what can the Irish central bankers advise their Greek counter-parts on?

The Irish central bankers could advise their Greek counter-parts on their experience hiring firms like BlackRock, Barclays and Boston Consulting to run a stress test and reorganize the banks.

Specifically, they could share

• how 30 million euros was paid to these firms for a solution that your humble blogger stated before the firms started would neither restore confidence nor stop the run on the banks' deposits;  

• that the run on the Irish banking system has continued months after the results of the stress test and reorganization were announced; and 

• that the ECB recently committed to paying 4 million euros for a report due in November 2011 on how to restore confidence in the Irish banking system.

Most likely though, the Irish central banker will advise their Greek counter-parts to spend lots of taxpayer money on a similar stress test and reorganization.  

Like Wall Street, the advice will be better for the advisor than for the recipient.  

• For the advisor, it provides cover lest Irish taxpayers question the wisdom of the stress test and reorganization - the central banker's defense is 'it must be a good idea because someone else did it too'; kind of like lemmings jumping off a cliff.  

• For the recipient, it provides an opportunity to loot the Greek taxpayer (or the EU taxpayers given that Greece is having difficulty repaying its debt).  After all, it cannot be justified on the grounds that it will restore confidence or stop the run on the banks.

Alternatively, the Irish central bankers could advise their Greek counter-parts that they wished they had pursued the only proven solution for restoring confidence and ending bank runs.  This solution involves implementing the FDR Framework and providing disclosure to all market participants of the current asset and liability-level data for each bank.

SENIOR OFFICIALS from the Central Bank have played a walk-on part in the unfolding Greek tragedy, prompting their counterparts in Athens from the wings on how to plot a resolution for their banks. 

Performing a role close to that of an all-knowing Irish Oracle at Delphi, two officials travelled to Athens in July and again earlier this month to advise the Greeks on how they stress-tested the Irish banks in an attempt to draw a final line under the banking crisis. 

The troika gods of the European Commission, the European Central Bank and the International Monetary Fund have looked favourably on the Irish stress tests as a winning formula for assessing risks in banking sectors in other struggling euro zone states.

Despite all evidence to the contrary that the stress tests were not a winning formula.  So maybe having Greece engage in this activity is to provide cover to the European Commission, the European Central Bank and the International Monetary Fund too!

The cost of bailing out the Irish banks has not increased since the March 2011 tests, the fifth attempt in more than two years to put a final bill on the banking disaster. 

Apparently success is defined as the Irish government not having to put more equity into the banking system for 6 months.  A measure of success that Warren Buffett would say is very similar to firing an arrow and then drawing a bullseye around where it has landed.

This definition of success has a couple of flaws.  First, it is not clear that the Irish government has access to the financial resources to put additional capital into the banks.  This is a bit of a problem given that the Irish Times reports that house prices continue to fall.  Second, bank equity is an easily manipulated accounting construct.  Simply practicing extend and pretend results in bank equity being higher than it would be if losses were realized.

As a result of the purported success of the Irish tests, the Central Bank was asked to send a delegation to Athens earlier this summer to help the Greek authorities handle their own banking woes.

"We can confirm that following a request from the Bank of Greece a small team from the Central Bank of Ireland travelled twice to the Bank of Greece to share experiences gained," a Central Bank spokesman said...

The officials advised the Greeks on the process followed in the Irish tests and how the test results influenced the reconstruction of the Irish banking system around the two "pillars" of Bank of Ireland and Allied Irish Banks. 

Two Greek banks were among eight lenders that failed EU-wide stress tests of 90 banks in July. 

Bank of Ireland and AIB both passed the EU tests the previous year, but the results were undermined when the Government was forced to seek bailout loans from the EU and IMF four months later. 

The subsequent Irish stress tests of the banks in March 2011 were not carried out exclusively by Central Bank officials, however. As part of their scrutiny, they called in consultants, including US asset manager BlackRock Solutions, to assess losses on the loan books of the Irish banks. 

BlackRock has since been recruited by the Greek central bank to evaluate the country's banks, which would be among the losers in a default by Greece. 

The Central Bank spent €30 million on external consultants to verify the tests on Bank of Ireland, AIB, EBS building society and Irish Life and Permanent. The results of the tests raised the cost of bailing out the banks by €24 billion to €70 billion. About €64 billion is being injected by the State.

And still the run on the Irish banking system continues as the failure to disclose current asset and liability-level data means that nobody knows if the banks are solvent or not.

The Looting of the Irish and its implications for Greece

It would be understandable if the Greeks did not want to repeat the Irish experience of selling their assets for a fraction of their value.  Particularly, because this blog has already laid out exactly how the opaque auctions run by Wall Street result in the seller receiving less than the fair value of their assets.

As reported in an article in the Independent, the Irish bank Anglo will not generate the sale price it was hoping for from selling its US loan-book.

Think of the size of the discount we are talking.

The first discount from fair value occurs when Wall Street sets the expectation for what they think the assets can be sold for.  Naturally, because Wall Street makes a very large fee if a transaction occurs, this price is set as low as possible consistent with getting the mandate to sell the assets.

The second discount from fair value occurs when, in conducting its opaque auction, Wall Street seizes on current events to explain why the bids from investors who require at least a 20% return on their investment came in lower than expected.

Both of these discounts could be eliminated by full disclosure to all market participants before the auction.  This disclosure will result in independent analysts assessing the value of the assets for sale.  This is the value for the assets that Wall Street should have to meet or exceed to get its fee.

Without this independent valuation, any seller, be it Irish or Greek, is going to receive much less than fair value for their assets.

AS many as 25 investment groups, including some of the biggest names in finance, have reportedly lodged bids to buy parts of Anglo's $9.5bn (€6.6bn) US loan portfolio. 

But US publications have suggested that Anglo may get as little as $7bn from the sale, significantly below the $7.5bn to $8bn the bank had been hoping for earlier in the year. 

Note the lack of an independent market valuation.

The news comes after Tuesday night's deadline for first-round bids on the portfolio of 248 commercial loans stretching from Manhattan to Boston to Florida. 

The bids were lodged amid massive uncertainty in the US, as the country contemplated the economic impact of its first ever ratings agency downgrade. 

As well as depressing prices, the crisis has put buyers' ability to fund their offers into sharp focus, and financing will be a key factor in determining who will go through to the second round. 

The excuse for why the price is lower than the seller hoped for.

Anglo has already ruled out taking any role in funding a bidder, a view the bank still holds despite recent market events, sources confirmed. 

Bidders for the book are believed to include Deutsche Bank, Goldman Sachs, JP Morgan Chase, Wells Fargo, Lone Star Funds, TPG Capital and Blackstone Group. 

Most bidders are acting in consortium and only bidding for a section of the loan book, meaning the most likely outcome is that the book will be sold off in tranches....

The bank's official deadline is to sell the US assets by December 31, but management is working towards doing a deal by the end of the third quarter. 

The Looting of the Irish reaches new heights

As predicted on this blog, the Irish government is maximizing the taxpayer losses by not disclosing the current asset and liability-level data for its banking system.

Without this disclosure, the markets cannot value the assets in the banking system and the individual banks.  Without this independent valuation, no one, including the Irish government, knows that it received remotely close to market value for the assets or the equity in the banks that it has sold.

For investment bankers, opacity is their friend as it prevents an independent assessment of value.

This blog described in detail how investment bankers would use opacity to screw the Irish taxpayers.  Incredibly, it has come to pass almost exactly as predicted.

The mechanism your humble blogger described Wall Street as using was an auction.  Information on the bank's assets and liabilities would be shared with a small group of investors.  These investors, all of whom have approximately the same rate of return hurdle, would then "bid" against each other.  Note that this auction guarantees no independent valuation by the market.  It also guarantees a hefty discount on the assets and equity.

What is critically important is that information that was not available to all market participants was shared.

Fast forward to last week.  The Irish government announced the investment by a group of these investors in one of the two banks the Irish government has publicly announced it would keep open.  This came after the government discovered that it was difficult to sell shares in a public offering for these banks where there was no transparency into their current asset level data.

Naturally, the investors, who had the extra information from their prior involvement, were in a position where they could assess an investment.  After that, it was just a question of the degree of looting.

As described in an Irish Times column,

THE LOGIC of the Government’s decision to let private equity into the Bank of Ireland party at this late stage in the game is not entirely obvious. 

Depending on how you calculate these things the taxpayer has put between €2.2 billion and €3.5 billion into Bank of Ireland, most of it when nobody else would have contemplated investing in the bank. 

The State’s investment came after it had taken the bank – along with its four peers – under the protective wing of the the exchequer and bankrupted the Republic in the process. 

Bank of Ireland to this day still continues to rely on State support for its survival. Any emergency borrowing it may have from the Irish Central Bank in order to meet liquidity demands are explicitly guaranteed by the Irish exchequer. Its vital borrowings from the European Central Bank are on the back of the Government guarantee bonds issued to it by the National Asset Management Agency in exchange for its toxic property and development loans. Nama has yet to turn a profit. 

The notion that the Bank of Ireland is not an ongoing burden on taxpayers is thus misleading. Until the bank can stand on its own two feet and attract sufficient deposits in its own right to repay its borrowings from the Central Bank and the ECB, the taxpayer remains firmly on the hook. 

For this reason alone the decision to sell 34.9 per cent of it to a group of private equity investors is questionable. 

The decision to sell it to them for €1.1 billion with no strings attached seems to verge on the foolish. 

The Government is keen to point out that the new investors are long-term value holders. That may well be the case, but what they are not is banks and arguably what Bank of Ireland needs right now is another bank.  

The best and simplest route back to viability for Bank of Ireland is to merge its badly damaged balance sheet with the balance sheet of a stronger bank. This has the potential to solve the liquidity problem overnight. 

Fairfax and its fellow north American investors do not have the facility or the inclination to lend balance sheet support to the bank. 

The best that Bank of Ireland can hope for in this regard is that the vote of confidence implied in the private equity investment will help it attract deposits. 

However, it is still likely that the bank will have to be sold to a larger one sooner rather than later and the big winners will be Fairfax and its co-investors. 

So, if the decision to sell down its stake in Bank of Ireland does not solve the underlying problem and represents bad value for the taxpayer, why did the Government do it? 

Could the advice from investment bankers who stood to make a substantial fee have played any role in the decision?

Well, it saves the Government €1.1 billion. Or to be precise, the Government will have to borrow €1.1 billion less this year. It’s a significant sum but will not in itself turn around the national finances. 

The Bank of Ireland deal is best understood in the context of a wider strategy for the sector. 

This in turn stands or falls on international acceptance that following the stress tests carried out earlier this year Irish banks are adequately capitalised. 

The Government believes a significant investment by an overseas institution in Bank of Ireland is the strongest possible endorsement of those stress tests. 

This blog has already documented how and why the stress test and subsequent banking industry reorganization carried out by the Irish government did not restore investor confidence.

Selling equity to distressed investors does not restore investor confidence.  Distressed investors are masters at maximizing their upside while minimizing their downside.  For example, it turns out that the distressed investors are getting approximately a 4% discount on their stock purchase.  This was not announced at the time the deal with the government was announced.

Who knows what else these investors have negotiated or what other investment positions they have that minimize their risk.

It has put particular emphasis on the fact that there is no risk sharing element to the deal and it was reported over the weekend that the Government rejected an approach from Texas Pacific to buy 15 per cent of Bank of Ireland because they wanted the Government to share any future losses at the bank.

The Irish government is going to absorb any future losses above the Bank of Ireland's capitalization.  The investors are not required to put in money to cover additional losses.

The only question is if there are future losses in excess of the Bank of Ireland's capitalization, will the investors' investment be wiped out first or will the investors be bailed out.

The price of the non-risk sharing approach appears to have been the attractive terms given to Fairfax and its partners who have ended up with 35 per cent. 

Would the Irish taxpayer have been better off with risk sharing had the same investment dollars been used to cover the next losses realized by Bank of Ireland and retaining 20 percent of the equity?

Hard to imagine that the Irish taxpayer would not have been better off as they essentially accepted the same deal only without retaining 20 percent of the equity.

You can argue of course that from this point of view the generous terms of the Fairfax deal are as damaging for the credibility of the stress tests as risk sharing. 

But the Government believes it’s a price worth paying because it eases the task of sorting out AIB and Irish Life Permanent in several ways. 

If Bank of Ireland needs to be taken over, the other two really need to be taken over. In theory the way is now cleared to find trade buyers for those two institutions and, realistically, there is only a limited number of them interested in Ireland. Although this assumes that any international bank looking at Ireland will no longer have a preference for Bank of Ireland, which seems naive. 

There are other “wins” from the State’s perspective in deciding to bring in private equity on generous terms at this stage. Not least that it could be 12 months, or never, before a trade buyer could be found for Bank of Ireland and one thing the Republic does not have is time when it comes to sorting out the banking system. 

Actually, the irish government had and still has plenty of time to provide current asset level disclosure.  Had it done so, it would have been easier and much less costly to the Irish taxpayer to sort out the banking system.

Moreover, there is also the argument that when you are selling your entire banking system, it makes sense to try and have a least one of the pillar institutions in diversified ownership. 

The arguments are quite finely balanced. But the good news is that while the State may once again have made a mistake – and will really only know if it has in a few years – it does appear to have its eyes open this time.